Pacific Financial Corp Earns Record $11.3 Million, or $1.06 per Share, for Full Year of 2018; Net Income Grew to $3.2 Million, or $0.30 per Share, for 4Q18

ABERDEEN, Wash., Jan. 24, 2019 (GLOBE NEWSWIRE) -- Pacific Financial Corporation (OTCQB: PFLC), the holding company for Bank of the Pacific, today reported net income of $11.3 million, or $1.06 per diluted share, for the year ended December 31, 2018, compared to $7.0 million, or $0.65 per diluted share, for the year ended December 31, 2017. Net income was $3.2 million, or $0.30 per diluted share, for the fourth quarter of 2018, compared to $3.2 million, or $0.30 per diluted share for the third quarter of 2018, and $1.4 million, or $0.13 per diluted share, for the fourth quarter of 2017. Earnings for 2017 were impacted by a write-down of its deferred tax asset resulting in an additional tax expense of $1.0 million for the fourth quarter. This was due to the passage of the Tax Cuts and Jobs Act of 2017, which lowered the corporate tax rate to 21% from 34%.

“We generated record profits for the fourth quarter and full year of 2018, highlighted by an expanded net interest margin of 4.58%, improved yields across all asset classes, and year-over-year solid core deposit growth with minimal increases in cost of funds,” said Denise Portmann, President & Chief Executive Officer. “Income before taxes increased 1% from the preceding quarter, 13% from the year ago quarter and 21% from the prior twelve months. Balance sheet mix and deposit pricing strategies contributed to growth in net interest income during the upsurge in interest rates initiated by the Federal Reserve throughout 2018. In addition, we continue to benefit from initiatives introduced over the past year which have enhanced workflow efficiencies and improved revenue and cost management.

“Credit quality remains solid, aided by continued low levels of adversely classified and nonperforming loans. Our risk management protocols guide the growth of our loan portfolio as we carefully monitor loan concentrations to stay within regulatory guidelines, particularly in commercial real estate. As a result, no provision for loan losses was booked throughout the year,” added Portmann. The contribution of residential mortgage lending to noninterest income was down 9%, 8% and 20% from the linked quarter, year-over-year quarter and prior year, respectively. Rising interest rates and housing prices, as well as tight housing supply are dampening home financing activities within our markets. Correspondingly, we continue to manage our staffing levels in this line of business. 

“The recently announced closures of the two branch locations in Naselle, WA and Warrenton, OR, are proceeding according to plan,” said Portmann. “Optimizing our branch network in light of increasing use of technology-based banking services plays a significant role in allocating capital resources. Resources are being redeployed to augment our technology-based product offerings, enhance our network infrastructure and strengthen our marketing data analytics.”

2018 Financial Highlights (as of, or for the period ended December 31, 2018, except as noted):

	•	Diluted earnings per share (“EPS”) was $0.30 for the fourth quarter of 2018, compared to $0.30 for the third quarter of 2018, and $0.13 for the fourth quarter of 2017. Diluted EPS was $1.06 for 2018, compared to $0.65 per diluted EPS for 2017.
	•	Income before tax increased 1% to $4.0 million, compared to $3.9 million for the third quarter of 2018 and increased 13% compared to $3.5 million for the fourth quarter of 2017. Income before tax increased 21% to $13.7 million compared to $11.3 million for the prior twelve months.
	•	Return on average assets (“ROAA”) increased to 1.39% and return on average equity (“ROAE”) was 13.76%, compared to 1.38% and 13.89%, respectively, for the third quarter of 2018, and 0.60% and 6.09%, respectively, for the fourth quarter of 2017. ROAA was 1.26% and ROAE was 12.63% for 2018, compared to 0.79% and 8.19%, respectively, for the year ended December 31, 2017. Industry peer ROAA was 1.04% and ROAE was 10.38% at September 30, 2018. [Industry peers comprise of 409 banks in the SNL Microcap U.S. Bank Index.]
	•	Net interest income increased 2% to $9.8 million, compared to $9.7 million for the third quarter of 2018 and increased 10% compared to $8.9 million for the fourth quarter of 2017. Net interest income increased 10% to $37.5 million for the year, from $34.0 million for 2017.
	•	Net interest margin, on a tax equivalent basis (“NIMTE”), expanded 3 basis points to 4.58%, compared to 4.55% in the preceding quarter and improved 26 basis points from 4.32% for the fourth quarter of 2017. NIMTE expanded 24 basis points to 4.52% for the year ended 2018, compared to 4.28% for 2017, reflecting improving yields on interest earning assets and slower growth in cost of funds. Industry peer NIM was 3.75%. [Industry peers are the 409 banks that comprised the SNL Microcap U.S. Bank Index, at September 2018.]
	•	Gross loans grew to $704.1 million versus $693.1 million, at September 30, 2018, and $688.4 million at December 31, 2017.
	•	Total deposits were $783.5 million, compared to $815.2 million at September 30, 2018, and $777.2 million at December 31, 2017. Non-interest-bearing deposits comprise 31% of total deposits.
	•	Asset quality remains solid:
		Loans 30 – 89 days delinquent, still on accrual status, were minimal at 0.36% of gross loans outstanding.  Net charge-offs totaled $18,000, or 0.01% of average gross loans in the fourth quarter of 2018, compared to $76,000, or 0.04% of average gross loans, in the third quarter of 2018 and $120,000, or 0.07% of average gross loans, in the fourth quarter of 2017.  Nonperforming assets were $700,000, or 0.08% of total assets, compared to $746,000, or 0.08% of total assets at September 30, 2018, and $2.2 million, or 0.25% of total assets at December 31, 2017.  Adversely classified loans were $7.8 million, or 1.10% of gross loans, versus $7.8 million, or 1.12% of gross loans, at September 30, 2018, and $7.5 million, or 1.10% of gross loans, at December 31, 2017.  No provision for loan losses was incurred in 2018 versus $272,000 in 2017.  The allowance for loan losses to gross loans declined to 1.29% at December 30, 2018 compared to 1.31% at September 30, 2018, and 1.32% at December 31, 2017.
	•	The Company’s consolidated capital ratios and the Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under current regulatory requirements.

Operating Results Overview

Total assets declined from the third quarter, mostly due to seasonal deposit outflows, which are typical of tourism markets in coastal Washington and Oregon. Deposits grew slightly year-over-year despite the withdrawal of $12.0 million in deposits in the second quarter associated with a relationship the Bank declined to offer a credit facility. Loans increased modestly year-over-year despite the payoff of several large non-owner occupied commercial real estate loans and the seasonal reduction in commercial lines of credit balances. Total assets were up slightly year-over-year, primarily due to the increase in loans and investment securities funded by redeployment of cash equivalents, growth in deposits and retained earnings. Liquidity remains strong, including unused borrowing capacity. Capital ratios continue to exceed the thresholds to be considered “Well-Capitalized” under published regulatory standards.

Balance Sheet Overview
(Unaudited)
	Dec 31,  2018				Sept 30,  2018			$  Change			%  Change			Dec 31,  2017			$ Change			% Change
Assets:	(Dollars in thousands, except per share data)
Cash and cash equivalents	$	22,188		$	80,121		$	(57,933	)		-72	%	$	34,571		$	(12,383	)		-36	%
Other interest earning deposits	3,250				994			2,256			227	%		994			2,256			227	%
Investment securities	122,610				104,343			18,267			18	%		110,767			11,843			11	%
Loans held-for-sale	6,204				7,745			(1,541	)		-20	%		10,886			(4,682	)		-43	%
Loans, net of deferred fees	703,103				692,092			11,011			2	%		687,319			15,784			2	%
Allowance for loan losses	(9,049		)		(9,067	)		18			0	%		(9,092	)		43			0	%
Net loans	694,054				683,025			11,029			2	%		678,227			15,827			2	%
Federal Home Loan Bank and Pacific Coast Bankers' Bank stock, at cost	2,407				2,409			(2	)		0	%		2,409			(2	)		0	%
Other assets	57,216				58,455			(1,239	)		-2	%		57,099			117			0	%
Total assets	$	907,929		$	937,092		$	(29,163	)		-3	%	$	894,953		$	12,976			1	%
Liabilities and Shareholders' Equity:
Total deposits	$	783,549		$	815,153		$	(31,604	)		-4	%	$	777,225		$	6,324			1	%
Borrowings	21,756				21,794			(38	)		0	%		21,906			(150	)		-1	%
Accrued interest payable and other liabilities	10,141				8,806			1,335			15	%		10,791			(650	)		-6	%
Shareholders' equity	92,483				91,339			1,144			1	%		85,031			7,452			9	%
Total liabilities and shareholders' equity	$	907,929		$	937,092		$	(29,163	)		-3	%	$	894,953		$	12,976			1	%
Common Stock Shares Outstanding	10,568,720				10,565,034			3,686			0	%		10,491,892			76,828			1	%
Book value per common share (1)	$	8.75		$	8.65		$	0.10			1	%	$	8.10		$	0.65			8	%
Tangible book value per common share (2)	$	7.47		$	7.37		$	0.10			1	%	$	6.82		$	0.65			10	%
Gross loans to deposits ratio	89.7		%		84.9	%		4.8	%					88.4	%		1.3	%
(1) Book value per common share is calculated as the total common shareholders' equity divided by the period ending number of common stock shares outstanding.
(2) Tangible book value per common share is calculated as the total common shareholders' equity less total intangible assets and liabilities, divided by the period ending number of common stock shares outstanding.

Net interest income increased from the prior three months, largely due to an increase in earning asset (primarily loan) yields, which outpaced growth in funding costs as a result of the recent rise in interest rates. Similarly, net interest income increased from the fourth quarter a year ago and from the prior year period, primarily as a result of the increase in earning assets and the impact of rising interest rates on earning asset yields.

Interest expense increased from the third quarter of 2018 and the like quarter a year ago, due to rate increases in non-maturity deposits, LIBOR-based junior subordinated debentures and public funds during the periods. This was partially offset by non-renewal of higher-cost brokered certificates of deposit. Interest expense increased for the year ended December 31, 2018, compared to 2017 for similar reasons.  

Pre-tax, pre-credit operating income (non-GAAP) for the fourth quarter of 2018 increased from the preceding quarter, primarily due to growth in net interest income, despite a decrease in gain on sale of real estate. Noninterest income for the year ended December 31, 2018 was down versus the full year of 2017. This was primarily due to the decline in gain on sale of real estate loans cited above, and one-time revenue of $340,000 earned from the sale of commercial loans and monetized fees from pricing of loans over the swap curve in the second quarter of 2017. This was partially mitigated by increases in deposit service charges and related fee income in the current period. 

Noninterest expense declined from the preceding quarter chiefly from reductions in compensation costs and state and local tax expense, the latter due to a $150,000 refund of state revenue taxes from a reconciliation of apportionable income in prior years. Gain on sale of real estate loans was down as compared to the prior periods, reflecting rising interest rates and tight housing supply that have impacted mortgage loan production. “December 2018 MLS data revealed inventory in our Western Washington and Oregon markets dipped below two months of supply for the first time since July. A year-over-year comparison of the number of new listings, pending sales, and closed sales show drops overall, while prices rose from the same month a year ago”, commented Portmann.

Income Statement Overview
(Unaudited)
			For the Three Months Ended,
			Dec 31,  2018			Sept 30,  2018			$  Change			%  Change			Dec 31,  2017			$ Change			% Change
			(Dollars in thousands, except per share data)
Interest and dividend income		$	10,519		$	10,337		$	182			2	%	$	9,495		$	1,024			11	%
Interest expense			700			686			14			2	%		593			107			18	%
	Net interest income		9,819			9,651			168			2	%		8,902			917			10	%
Loan loss provision			-			-			-			0	%		-			-			0	%
Noninterest income			2,409			2,648			(239	)		-9	%		2,625			(216	)		-8	%
Noninterest expense			8,264			8,392			(128	)		-2	%		8,013			251			3	%
Income before income taxes			3,964			3,907			57			1	%		3,514			450			13	%
Income tax expense			719			724			(5	)		-1	%		2,156			(1,437	)		-67	%
	Net Income	$	3,245		$	3,183		$	62			2	%	$	1,358		$	1,887			139	%
Average common shares outstanding - basic			10,565,595			10,563,104			2,491			0	%		10,482,545			83,050			1	%
Average common shares outstanding - diluted			10,673,908			10,685,274			(11,366	)		0	%		10,661,422			12,486			0	%
Income per common share
	Basic	$	0.31		$	0.30		$	0.01			3	%	$	0.13		$	0.18			138	%
	Diluted	$	0.30		$	0.30		$	-			0	%	$	0.13		$	0.17			131	%
Effective tax rate			18.1	%		18.5	%		-0.4	%					61.4	%		-43.3	%

			For the Year Ended,
			Dec 31,  2018			Dec 31,  2017			$  Change			%  Change
			(Dollars in thousands, except per share data)
Interest and dividend income		$	40,060		$	36,445		$	3,615			10	%
Interest expense			2,590			2,396			194			8	%
	Net interest income		37,470			34,049			3,421			10	%
Loan loss provision			-			272			(272	)		-100	%
Noninterest income			10,031			10,523			(492	)		-5	%
Noninterest expense			33,793			32,976			817			2	%
Income before income taxes			13,708			11,324			2,384			21	%
Income tax expense			2,378			4,361			(1,983	)		-45	%
	Net Income	$	11,330		$	6,963		$	4,367			63	%
Average common shares outstanding - basic			10,551,174			10,452,014			99,160			1	%
Average common shares outstanding - diluted			10,673,393			10,647,279			26,114			0	%
Income per common share
	Basic	$	1.07		$	0.67		$	0.40			60	%
	Diluted	$	1.06		$	0.65		$	0.41			63	%
Effective tax rate			17.3	%		38.5	%		-21.2	%

The following tables provide the reconciliation of net income to pre-tax, pre-credit operating income (non-GAAP):

Reconciliation of Non-GAAP Measure
(Unaudited)
			For the Three Months Ended,
			Dec 31,  2018		Sept 30,  2018		$  Change		%  Change		Dec 31,  2017		$ Change		% Change
Non-GAAP Operating Income			(Dollars in thousands)
Net Income		$	3,245	$	3,183	$	62		2%	$	1,358	$	1,887		139%
	Loan loss provision		-		-		-		0%		-		-		0%
	Loss on real estate owned, net		-		-		-		0%		-		-		0%
	Income tax expense		719		724		(5)		-1%		2,156		(1,437)		-67%
Pre-tax, pre-credit operating income		$	3,964	$	3,907	$	57		1%	$	3,514	$	450		13%
			For the Year Ended,
			Dec 31,  2018		Dec 31,  2017		$  Change		%  Change
Non-GAAP Operating Income			(Dollars in thousands)
Net Income		$	11,330	$	6,963	$	4,367		63%
	Loan loss provision		-		272		(272)		-100%
	Loss on real estate owned, net		-		34		(34)		-100%
	Income tax expense		2,378		4,361		(1,983)		-45%
Pre-tax, pre-credit operating income		$	13,708	$	11,630	$	2,078		18%

Noninterest Income

Noninterest income in the fourth quarter of 2018 declined compared to the linked quarter and the year-over-year quarter, primarily due a decrease in revenue from sale of residential mortgage loans versus the prior period. Similarly, for 2018, noninterest income declined versus 2017, primarily due to factors related to the decline in demand for residential mortgages for the reasons commented below. Deposit service charges and other related fees were increased earlier in the current year consistent with product pricing in the market, resulting in increases in revenue from these sources year-over-year. “Recent increases in mortgage rates have moderated demand for refinancing. Demand for purchase financing has slowed as the increase in mortgage rates are beginning to price some prospective purchasers out of the market. Supply constraints from increased governmental regulations governing real estate development over the past several years, and resulting increases in housing prices, have also contributed to the recent dampened mortgage financing activity,” Portmann noted.

Noninterest Income
(Unaudited)
			Dec 31,  2018		Sept 30,  2018		$  Change		%  Change		Dec 31,  2017		$ Change		% Change
			(Dollars in thousands)
Service charges on deposits		$	507	$	504	$	3		1%	$	474	$	33		7%
Gain on sale of loans, net			941		1,155		(214)		-19%		1,406		(465)		-33%
Gain on sale of securities available for sale, net			-		-		-		0%		(70)		70		-100%
Earnings on bank owned life insurance			111		108		3		3%		109		2		2%
Other noninterest income
	Fee income		811		871		(60)		-7%		661		150		23%
	Other		39		10		29		290%		45		(6)		-13%
Total noninterest income		$	2,409	$	2,648	$	(239)		-9%	$	2,625	$	(216)		-8%
			For the Year Ended,
			Dec 31,  2018		Dec 31,  2017		$  Change		%  Change
			(Dollars in thousands)
Service charges on deposits		$	2,034	$	1,856	$	178		10%
Gain on sale of loans, net			4,103		5,303		(1,200)		-23%
Gain on sale of securities available for sale, net			-		9		(9)		-100%
Earnings on bank owned life insurance			432		440		(8)		-2%
Other noninterest income
	Fee income		3,331		2,575		756		29%
	Other		131		340		(209)		-61%
Total noninterest income		$	10,031	$	10,523	$	(492)		-5%

Noninterest Expense

Noninterest expenses declined from the preceding quarter chiefly from reductions in compensation costs and state and local tax expense, the latter due to a $150,000 refund of state revenue taxes from a reconciliation of apportionable income for in prior years. This was partially offset by a one-time increase of $62,000 in occupancy expense due to a write-down in book value of a building to be donated to a rural hospital district in our marketplace. Noninterest expenses grew compared to the year-over-year quarter, mainly due to data processing and software expense incurred as a result of continued introduction of technology solutions to augment cyber-security and enhance productivity. 

Noninterest expenses for 2018 increased compared to 2017, primarily due to the addition of commercial banking production personnel in higher growth markets and an increase in bonus accrual expense. In addition, technology and software amortization expense increased to support the technology initiatives mentioned above. These increases were offset by a decline in $547,000 in professional fees paid to a firm providing process improvement consulting in the prior year.

Noninterest Expense
(Unaudited)
			For the Three Months Ended,
			Dec 31, 2018			Sept 30,  2018		$  Change			%  Change			Dec 31,  2017		$ Change			% Change
			(Dollars in thousands)
Salaries and employee benefits		$	5,186		$	5,328	$	(142	)		-3	%	$	5,181	$	5			0	%
Occupancy			606			524		82			16	%		498		108			22	%
Equipment			246			255		(9	)		-4	%		262		(16	)		-6	%
Data processing			740			726		14			2	%		575		165			29	%
Professional services			193			173		20			12	%		137		56			41	%
State and local taxes			(15	)		131		(146	)		-111	%		123		(138	)		-112	%
FDIC and State assessments			73			84		(11	)		-13	%		120		(47	)		-39	%
Other noninterest expense:
	Director fees		67			65		2			3	%		71		(4	)		-6	%
	Communication		74			73		1			1	%		70		4			6	%
	Advertising		95			82		13			16	%		80		15			19	%
	Professional liability insurance		51			49		2			4	%		43		8			19	%
	Amortization		88			92		(4	)		-4	%		86		2			2	%
	Other		860			810		50			6	%		767		93			12	%
Total noninterest expense		$	8,264		$	8,392	$	(128	)		-2	%	$	8,013	$	251			3	%

 

			For the Year Ended,
			Dec 31,  2018		Dec 31,  2017		$ Change			% Change
			(Dollars in thousands)
Salaries and employee benefits		$	21,265	$	20,565	$	700			3	%
Occupancy			2,207		2,019		188			9	%
Equipment			1,087		1,100		(13	)		-1	%
Data processing			2,862		2,297		565			25	%
Professional services			756		1,270		(514	)		-40	%
Other real estate owned write-downs			-		47		(47	)		-100	%
Other real estate owned operating costs			6		62		(56	)		-90	%
State and local taxes			360		588		(228	)		-39	%
FDIC and State assessments			393		462		(69	)		-15	%
Other noninterest expense:
	Director fees		264		269		(5	)		-2	%
	Communication		303		269		34			13	%
	Advertising		341		323		18			6	%
	Professional liability insurance		193		185		8			4	%
	Amortization		374		86		288			335	%
	Loss on real estate owned, net		-		34		(34	)		-100	%
	Other		3,382		3,400		(18	)		-1	%
Total noninterest expense		$	33,793	$	32,976	$	817			2	%

Income Tax Provision

For the fourth quarter of 2018, Pacific Financial recorded $719,000 in income tax expense with an effective tax rate of 18.1%. The amount included a $78,000 refund due to a refreshed cost segregation analysis performed on premises constructed during a prior period. For the third quarter of 2018, tax expense was $724,000 with an effective tax rate of 18.5%, reflecting the new lower federal corporate rate. For the fourth quarter of 2017, tax expense was $2.2 million, which included a $1.0 million write-down of its deferred tax asset. Similarly, tax expense for the year ended December 31, 2018, was $2.4 million versus $4.4 million for 2017. In addition to the lower federal tax rates for the current period, resulting from the Tax Cuts and Jobs Act enacted on December 22, 2017, Pacific Financial also pays Oregon corporate income tax on profits and Washington Business and Occupation tax on revenues.

Financial Performance Overview
(Unaudited)
	For the Three Months Ended
	Dec 31,  2018			Sept 30,  2018			Change			Dec 31,  2017			Change
Performance Ratios
Return on average assets, annualized	1.39	%		1.38	%		0.01			0.60	%		0.79
Return on average equity, annualized	13.76	%		13.89	%		(0.13	)		6.09	%		7.67
Efficiency ratio (1)	67.58	%		68.23	%		(0.65	)		69.52	%		(1.94	)
(1) Non-interest expense divided by net interest income plus noninterest income.
	For the Year Ended,
	Dec 31,  2018			Dec 31,  2017			Change
Performance Ratios
Return on average assets, annualized	1.26	%		0.79	%		0.47
Return on average equity, annualized	12.63	%		8.19	%		4.44
Efficiency ratio (1)	71.14	%		73.98	%		(2.84	)
(1) Non-interest expense divided by net interest income plus noninterest income.

 

LIQUIDITY

Cash and Cash Equivalents and Investment Securities
(Unaudited)
				Dec 31,  2018		% of Total			Sept 30,  2018		% of Total			$  Change			%  Change			Dec 31,  2017		Total			$  Change			%  Change
				(Dollars in thousands)
Cash on hand and in banks			$	15,899		11	%	$	14,767		8	%	$	1,132			8	%	$	14,667		9	%	$	1,232			8	%
Interest bearing deposits				6,289		4	%		65,354		35	%		(59,065	)		-90	%		19,904		14	%		(13,615	)		-68	%
Other interest earning deposits				3,250		2	%		994		1	%		2,256			227	%		994		1	%		2,256			227	%
	Total cash equivalents and interest earning deposits			25,438		17	%		81,115		44	%		(55,677	)		-69	%		35,565		24	%		(10,127	)		-28	%
Investment securities:
	Collateralized mortgage obligations: agency issued			40,247		27	%		35,789		19	%		4,458			12	%		39,719		27	%		528			1	%
	Collateralized mortgage obligations: non-agency			176		0	%		191		0	%		(15	)		-8	%		257		0	%		(81	)		-32	%
	Mortgage-backed securities: agency issued			22,393		15	%		14,190		8	%		8,203			58	%		15,775		11	%		6,618			42	%
	U.S. Government and agency securities			4,185		3	%		4,193		2	%		(8	)		0	%		2,483		2	%		1,702			69	%
	Corporate bonds			959		1	%		-		0	%		959			100	%		-		0	%		959			100	%
	State and municipal securities			54,650		37	%		49,980		27	%		4,670			9	%		52,533		36	%		2,117			4	%
		Total investment securities		122,610		83	%		104,343		56	%		18,267			18	%		110,767		76	%		11,843			11	%
Total cash equivalents and investment securities			$	148,048		100	%	$	185,458		100	%	$	(37,410	)		-20	%	$	146,332		100	%	$	1,716			1	%
Total cash equivalents and investment securities
	as a percent of total assets					16	%				20	%										19	%

“Liquidity remains strong based on existing levels of combined cash equivalents, investment securities and unused borrowing capacity. Seasonal outflows typical for this time of year impacted total deposits during the quarter,” said Douglas N. Biddle, EVP and Chief Financial Officer. “Our investment securities include a large component of fully amortized U.S. agency collateralized mortgage and mortgage-backed securities, for which we expect to have limited extension risk. The securities portfolio also contains municipal securities rated A or better.” The expected modified duration (adjusted for calls, consensus pre-payment speeds and rate adjustment dates) of the investment portfolio was 3.8 years at December 31, 2018; 4.0 years at September 30, 2018, and 4.0 years at December 31, 2017.

The Bank had $8.4 million in outstanding borrowings against its $195.0 million in established borrowing capacity with the Federal Home Loan Bank of Des Moines (FHLB) at December 31, 2018. The Bank had $8.4 million and $8.5 million in outstanding borrowings with the FHLB at September 30, 2018, and December 31, 2017, respectively. The Bank’s borrowing facility with the FHLB is subject to collateral and stock ownership requirements. The Bank also has available a discount window primary credit line with the Federal Reserve Bank of San Francisco of approximately $52.5 million, subject to collateral requirements, and $16.0 million from correspondent banks, with no balance outstanding on any of these facilities.

LOANS

	Loans by Category
	(Unaudited)
				Dec 31,  2018			% of Gross Loans			Sept 30,  2018			% of Gross Loans			$  Change			%  Change			Dec 31,  2017			% of Gross Loans			$  Change			%  Change
				(Dollars in thousands)
	Commercial and agricultural		$	140,167			20	%	$	135,204			20	%	$	4,963			4	%	$	138,629			21	%	$	1,538			1	%
	Real estate:
	Construction and development			47,291			7	%		49,697			7	%		(2,406	)		-5	%		62,980			9	%		(15,689	)		-25	%
	Residential 1-4 family			89,091			13	%		90,394			13	%		(1,303	)		-1	%		88,055			13	%		1,036			1	%
	Multi-family			30,948			4	%		31,134			4	%		(186	)		-1	%		22,333			3	%		8,615			39	%
	Commercial real estate -- owner occupied			142,761			20	%		144,349			21	%		(1,588	)		-1	%		139,163			20	%		3,598			3	%
	Commercial real estate -- non owner occupied			152,017			22	%		138,255			20	%		13,762			10	%		139,169			20	%		12,848			9	%
	Farmland			28,876			4	%		29,075			4	%		(199	)		-1	%		30,196			4	%		(1,320	)		-4	%
	Consumer			72,946			10	%		74,998			11	%		(2,052	)		-3	%		67,890			10	%		5,056			7	%
		Gross Loans		704,097			100	%		693,106			100	%		10,991			2	%		688,415			100	%		15,682			2	%
		Less:  allowance for loan losses		(9,049	)					(9,067	)					18						(9,092	)					43
		Less:  deferred fees		(994	)					(1,014	)					20						(1,096	)					102
		Net loans	$	694,054					$	683,025					$	11,029					$	678,227					$	15,827

 

Loan Concentration
(Unaudited)
			Dec 31, 2018		% of Risk Based Capital			Sept 30,  2018		% of Risk Based Capital			Change			Dec 31,  2017		% of Risk Based Capital			Change
			(Dollars in thousands)
Commercial and agricultural		$	140,167		138	%	$	135,204		134	%		4	%	$	138,629		148	%		-10	%
Real estate:
Construction and development			47,291		47	%		49,697		49	%		-2	%		62,980		67	%		-20	%
Residential 1-4 family			89,091		88	%		90,394		89	%		-1	%		88,055		94	%		-6	%
Multi-family			30,948		30	%		31,134		31	%		-1	%		22,333		24	%		6	%
Commercial real estate -- owner occupied			142,761		141	%		144,349		143	%		-2	%		139,163		149	%		-8	%
Commercial real estate -- non owner occupied			152,017		150	%		138,255		137	%		13	%		139,169		149	%		1	%
Farmland			28,876		28	%		29,075		29	%		-1	%		30,196		32	%		-4	%
Consumer			72,946		72	%		74,998		74	%		-2	%		67,890		72	%		0	%
	Gross Loans	$	704,097				$	693,106							$	688,415
Regulatory Commercial Real Estate		$	225,806		222	%	$	213,891		212	%		10	%	$	215,087		230	%		-8	%
Total Risk Based Capital*		$	101,487				$	101,031							$	93,660
*Bank of the Pacific

The loan portfolio continues to be well-diversified and is originated predominately within our Western Washington and Oregon markets. Decreases during the current quarter occurred in commercial real estate, mainly due to the expected payoff from long-term financing sources. Commercial loan balances increased during the current quarter to finance operations in the normal course of business. The portfolio includes $31.6 million in LIBOR-based and $133.3 million in Wall Street Journal Prime-based floating rate commercial, commercial real estate and home equity loans. The portfolio also includes $14.2 million in purchased government-guaranteed commercial and commercial real estate loans and $61.6 million in indirect consumer loans to finance luxury and classic cars as a part of a strategy to diversify the loan portfolio. The indirect consumer loans have been made to individuals with high credit scores and have exhibited very low losses to date. The Company manages new loan origination volume using concentration limits that establish maximum exposure levels by designated industry segment, real estate product types, geography and single borrower limits. The Bank’s recent portfolio growth includes commercial real estate loans, which are carefully managed to meet regulatory guidelines. 

DEPOSITS

Deposits by Category
(Unaudited)
		Dec 31,  2018		% of Total			Sept 30,  2018		% of Total			$ Change			%  Change			Dec 31,  2017		% of Total			$  Change			%  Change
		(Dollars in thousands)
Interest-bearing demand	$	191,530		24	%	$	201,058		24	%	$	(9,528	)		-5	%	$	190,216		25	%	$	1,314			1	%
Money market		162,238		21	%		161,012		20	%		1,226			1	%		142,491		19	%		19,747			14	%
Savings		101,408		13	%		102,680		13	%		(1,272	)		-1	%		89,303		11	%		12,105			14	%
Time deposits (CDs)		86,188		11	%		87,874		11	%		(1,686	)		-2	%		103,871		13	%		(17,683	)		-17	%
Total interest-bearing deposits		541,364		69	%		552,624		68	%		(11,260	)		-2	%		525,881		68	%		15,483			3	%
Non-interest bearing demand		242,185		31	%		262,529		32	%		(20,344	)		-8	%		251,344		32	%		(9,159	)		-4	%
Total deposits	$	783,549		100	%	$	815,153		100	%	$	(31,604	)		-4	%	$	777,225		100	%	$	6,324			1	%

Total deposits decreased from the linked quarter, due to seasonal deposit outflows as noted above. Time deposits continue to decline as a component of funding, as retail depositors are reluctant to lock in relatively low interest rates for an extended period. In addition, balances of brokered deposits also declined during these periods. The proportion of noninterest bearing deposits to total deposits remained stable year-over-year.

Brokered certificates of deposit totaled $29.6 million, down from $32.5 million at September 30, 2018, and $42.3 million at December 31, 2017. The brokered deposits were acquired during the latter part of 2015 and early 2016 with fixed rates and terms ranging from 2 to 5 years. “These deposits were obtained to lock in historically low rates to enhance the Bank’s interest rate risk mitigation strategies,” explained Biddle.

CAPITAL

Pacific Financial Corporation, and its subsidiary Bank of the Pacific, met the thresholds to be considered “well-capitalized” under regulatory standards for total risk-based capital, Tier 1 risk-based capital, common equity Tier 1 and Tier 1 leverage capital. All ratios have decreased compared to the linked, due to the declaration of an annual cash dividend during the current quarter. These ratios have increased versus the prior year quarter primarily due to the retention of earnings. This is despite the impact on capital of the unrealized gain/(loss) on investment securities classified as “Available for Sale”, which was $(901,000), $(2.0 million) and $(83,000) as of December 31, 2018, September 30, 2018, and December 31, 2017, respectively, due to the recent increase in interest rates. In addition, the decrease in tangible assets as compared to the linked quarter contributed to a 12-basis point increase in the Tangible Common Equity Ratio (TCE), despite the declaration of the cash dividend mentioned above. 

The total risk-based capital ratios of the Company include $13.4 million of junior subordinated debentures, all of which qualified as Tier 1 capital under guidance issued by the Federal Reserve. As provided in the Dodd-Frank Act, the Company expects to continue to rely on these junior subordinated debentures as part of its regulatory capital.

The following table summarizes the capital measures of the Company and the Bank respectively, at the dates listed below.

Capital Measures
(unaudited)
	Dec 31,  2018			Sept 30,  2018			Change			Dec 31,  2017			Change			Well Capitalized Under Prompt Correction Action Regulations*
Pacific Financial Corporation
Total risk-based capital ratio	13.36	%		13.61	%		(0.25	)		12.69	%		0.67			N/A
Tier 1 risk-based capital ratio	12.17	%		12.40	%		(0.23	)		11.46	%		0.71			N/A
Common equity tier 1 ratio	10.47	%		10.67	%		(0.20	)		9.71	%		0.76			N/A
Leverage ratio	10.21	%		10.30	%		(0.09	)		9.56	%		0.65			N/A
Tangible common equity ratio	8.83	%		8.43	%		0.40			8.16	%		0.67			N/A
Bank of the Pacific
Total risk-based capital ratio	13.30	%		13.49	%		(0.19	)		12.63	%		0.67			10.5%
Tier 1 risk-based capital ratio	12.09	%		12.26	%		(0.17	)		11.40	%		0.69			8.5%
Common equity tier 1 ratio	12.09	%		12.26	%		(0.17	)		11.40	%		0.69			7.0%
Leverage ratio	10.14	%		10.18	%		(0.04	)		9.51	%		0.63			7.5%
*Includes Basel III 2019 Capital Conservation Buffer

 

Net Interest Margin

Net interest margin improved from the preceding quarter and from a year ago, primarily due to increases in average loan yields. Recent increases in interest rates initiated by the Federal Reserve had a positive impact on asset yields during the period. Net interest margin for the current year improved as compared to the prior year for similar reasons.

Cost of deposits remained relatively unchanged compared to the third quarter and year-over-year periods. The non-renewal of higher-cost long-term fixed rate brokered deposits favorably impacted funding costs during these respective periods. Improvement in loan and investment security yields offset increases in the cost of LIBOR-based junior subordinated debentures as a result of rising interest rates in the current quarter as compared to the linked and year-over-year periods.

The following tables set forth information regarding average balances of interest-earning assets and interest-bearing liabilities and the resultant yields or cost, and the net interest margin on a tax equivalent basis. Loans held for sale and non-accrual loans are included in total loans.

Net Interest Margin
(Unaudited)
(Annualized, tax-equivalent basis)
			For the Three Months Ended,
			Dec 31, 2018			Sept 30, 2018			$  Change			%   Change			Dec 31, 2017		$ Change			% Change
Average Balances			(Dollars in thousands)
Gross loans		$	692,043		$	695,011		$	(2,968	)		0	%	$	682,688	$	9,355			1	%
Loans held for sale		$	5,793		$	8,860		$	(3,067	)		-35	%	$	9,475	$	(3,682	)		-39	%
Investment securities		$	164,472		$	149,028		$	15,444			10	%	$	147,863	$	16,609			11	%
Total interest-earning assets		$	862,308		$	852,899		$	9,409			1	%	$	840,026	$	22,282			3	%
Non-interest bearing demand deposits		$	255,968		$	251,847		$	4,121			2	%	$	265,002	$	(9,034	)		-3	%
Interest bearing deposits		$	545,616		$	543,436		$	2,180			0	%	$	519,595	$	26,021			5	%
Borrowings		$	21,769		$	21,943		$	(174	)		-1	%	$	21,919	$	(150	)		-1	%
Total interest-bearing liabilities		$	567,385		$	565,379		$	2,006			0	%	$	541,514	$	25,871			5	%
Total Equity		$	93,560		$	90,903		$	2,657			3	%	$	88,466	$	5,094			6	%
			For the Three Months Ended,
			Dec 31, 2018			Sept 30, 2018			Change			Dec 31, 2017			Change
Yield on average gross loans (1)			5.42	%		5.35	%		0.07			5.08	%		0.34
Yield on average investment securities (1)			2.66	%		2.57	%		0.09			2.37	%		0.29
Cost of average interest bearing deposits			0.37	%		0.37	%		-			0.34	%		0.03
Cost of average borrowings			3.39	%		3.34	%		0.05			2.73	%		0.66
Cost of average total deposits and borrowings			0.34	%		0.33	%		0.01			0.29	%		0.05
Yield on average interest-earning assets			4.90	%		4.86	%		0.04			4.60	%		0.30
Cost of average interest-bearing liabilities			0.49	%		0.48	%		0.01			0.43	%		0.06
Net interest spread			4.41	%		4.38	%		0.03			4.17	%		0.24
Net interest margin (1)			4.58	%		4.55	%		0.03			4.32	%		0.26
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a rate of 21% as of December 31, 2018 and September 30, 2018 and 34% as of December 31, 2017.

			For the Year Ended,
			Dec 31,  2018			Dec 31,  2017			$  Change			%  Change
Average Balances			(Dollars in thousands)
Gross loans		$	693,408		$	672,991		$	20,417			3	%
Loans held for sale		$	7,405		$	7,702		$	(297	)		-4	%
Investment securities		$	139,152		$	135,352		$	3,800			3	%
Interest-earning assets		$	839,965		$	816,045		$	23,920			3	%
Non-interest bearing demand deposits		$	249,255		$	242,290		$	6,965			3	%
Interest bearing deposits		$	533,541		$	523,007		$	10,534			2	%
Borrowings		$	22,241		$	22,080		$	161			1	%
Interest-bearing liabilities		$	555,782		$	545,087		$	10,695			2	%
Total Equity		$	89,676		$	84,976		$	4,700			6	%
			For the Year Ended,
			Dec 31,  2018			Dec 31,  2017			Change
Net Interest Margin
Yield on average gross loans (1)			5.27	%		5.01	%		0.26
Yield on average investment securities (1)			2.60	%		2.40	%		0.20
Cost of average interest bearing deposits			0.35	%		0.35	%		-
Cost of average borrowings			3.29	%		2.64	%		0.65
Cost of average total deposits and borrowings			0.32	%		0.30	%		0.02
Yield on average interest-earning assets			4.83	%		4.58	%		0.25
Cost of average interest-bearing liabilities			0.47	%		0.44	%		0.03
Net interest spread			4.36	%		4.14	%		0.22
Net interest margin (1)			4.52	%		4.28	%		0.24
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a rate of 21% and 34% as of December 31, 2018 and December 31, 2017, respectively.

ASSET QUALITY

Asset quality continues to be strong as levels of adversely classified and non-performing assets remain at low levels. Total 30-89-day delinquencies did increase primarily due a delay in payoff of a $1.3 million commercial relationship from another bank. Subsequently, the relationship has been brought current. The payoff is contingent on an assumption of a government guarantee by the new lender. Approval of the assumption by the SBA has been held up due to the partial federal government shutdown. The relationship is now current. However, delinquencies remained below 0.50%, a positive leading indicator of future credit quality. Adversely classified loans remained unchanged from the linked and prior year quarter. Adversely classified loans to total gross loans was 1.10% the end of the quarter compared to 1.12% at the linked quarter and 1.10% in the year ago quarter. 

Adversely Classified Loans and Securities
(Unaudited)
		Dec 31,  2018			Sept 30,  2018			$  Change			% Change			Dec 31,  2017			$  Change			% Change
		(Dollars in thousands)
Rated substandard or worse, but not impaired	$	6,723		$	6,733		$	(10	)		0	%	$	5,017		$	1,706			34	%
Impaired		1,043			1,044			(1	)		0	%		2,529			(1,486	)		-59	%
Total adversely classified loans¹	$	7,766		$	7,777		$	(11	)		0	%	$	7,546		$	220			3	%
Gross loans (excluding deferred loan fees)	$	704,097		$	693,106		$	10,991			2	%	$	688,415		$	15,682			2	%
Adversely classified loans to gross loans		1.10	%		1.12	%								1.10	%
Allowance for loan losses	$	9,049		$	9,067		$	(18	)		0	%	$	9,092		$	(43	)		0	%
Allowance for loan losses as a percentage of adversely classified loans		116.52	%		116.59	%								120.49	%
Allowance for loan losses to total impaired loans		867.59	%		868.49	%								359.51	%
Adversely classified loans to total assets		0.86	%		0.83	%								0.84	%
Delinquent loans to gross loans, not in nonaccrual status		0.36	%		0.18	%								0.04	%
¹Adversely classified loans are defined as loans having a well-defined weakness or weaknesses related to the borrower's financial capacity or to pledged collateral that may jeopardize the repayment of the debt.  They are characterized by the possibility that the Bank may sustain some loss if the deficiencies giving rise to the substandard classification are not corrected. Note that any loans internally rated worse than substandard are included in the impaired loan totals.

Nonperforming assets remained relatively unchanged from three months ago. As a result, there was no change in the percentage of nonperforming assets to total assets between those periods. Similarly, nonperforming assets were below the amount of the prior year quarter, primarily due to various payoffs and reductions achieved during the intervening quarters.

Nonperforming Assets
(Unaudited)
		Dec 31,  2018			Sept 30,  2018			$  Change			%  Change			Dec 31,  2017			$  Change			% Change
		(Dollars in thousands)
Loans on nonaccrual status	$	700		$	696		$	4			1	%	$	2,163		$	(1,463	)		-68	%
Total nonaccrual loans		700			696			4			1	%		2,163			(1,463	)		-68	%
Other real estate owned and foreclosed assets		-			50			(50	)		-100	%		50			(50	)		-100	%
Total nonperforming assets	$	700		$	746		$	(46	)		-6	%	$	2,213		$	(1,513	)		-68	%
Restructured performing loans	$	343		$	348		$	(5	)		-1	%	$	366		$	(23	)		-6	%
Accruing loans past due 90 days or more	$	-		$	-		$	-			0	%	$	-		$	-			0	%
Percentage of nonperforming assets to total assets		0.08	%		0.08	%								0.25	%
Nonperforming loans to total loans		0.10	%		0.10	%								0.31	%

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is managed in concert with loan growth, credit quality and market conditions. With changes in the loan portfolio composition over the past several years and overall improvement in credit quality, loss factors used in estimates to establish reserve levels have declined commensurately.

Net charge-offs were minimal in the fourth quarter, a decline from the linked quarter and the fourth quarter a year ago. Net charge-offs were below those from like periods for 2017, which included a $121,000 charge-off related to the payoff of a $2.0 million adversely classified commercial loan participation. Charge-offs incurred during the twelve months ending December 31, 2018, were comprised primarily of consumer loans, all of which were modest in size. “The low level of charge-offs and ratio of net loan charge-offs to average gross loans demonstrate the solid credit quality of the portfolio,” said Biddle. The overall risk profile of the loan portfolio continues to be modest, demonstrating the solid credit risk management framework in place. The trend of future provisions for loan losses will depend primarily on economic conditions, growth in the loan portfolio, level of adversely-classified assets and changes in collateral values.

Allowance for Loan Losses
(Unaudited)
		For the Three Months Ended,
		Dec 31,  2018			Sept 30,  2018			$  Change			% Change			Dec 31,  2017			$  Change			% Change
		(Dollars in thousands)
Gross loans outstanding at end of period	$	704,097		$	693,106		$	10,991			2	%	$	688,415		$	15,682			2	%
Average loans outstanding, gross	$	692,043		$	695,011		$	(2,968	)		0	%	$	682,688		$	9,355			1	%
Allowance for loan losses, beginning of period	$	9,067		$	9,143		$	(76	)		-1	%	$	9,212		$	(145	)		-2	%
Commercial		-			(4	)		4			-100	%		(10	)		10			-100	%
Commercial Real Estate		-			-			-			0	%		-			-			0	%
Residential Real Estate		-			-			-			0	%		-			-			0	%
Consumer		(22	)		(103	)		81			-79	%		(113	)		91			-81	%
Total charge-offs		(22	)		(107	)		85			-79	%		(123	)		101			-82	%
Commercial		-			23			(23	)		-100	%		2			(2	)		-100	%
Commercial Real Estate		-			-			-			0	%		-			-			0	%
Residential Real Estate		-			-			-			0	%		-			-			0	%
Consumer		4			8			(4	)		-50	%		1			3			300	%
Total recoveries		4			31			(27	)		-87	%		3			1			NM
Net recoveries/(charge-offs)		(18	)		(76	)		58			-76	%		(120	)		102			-85	%
Provision charged to income		-			-			-			0	%		-			-			0	%
Allowance for loan losses, end of period	$	9,049		$	9,067		$	(18	)		0	%	$	9,092		$	(43	)		0	%
Ratio of net loans charged-off to average
gross loans outstanding, annualized		0.01	%		0.04	%		-0.03	%					0.07	%		-0.06	%
Ratio of allowance for loan losses to
gross loans outstanding		1.29	%		1.31	%		-0.02	%					1.32	%		-0.03	%

		For the Year Ended,
		Dec 31,  2018			Dec 31,  2017			$  Change			% Change
		(Dollars in thousands)
Gross loans outstanding at end of period	$	704,097		$	688,415		$	15,682			2	%
Average loans outstanding, gross	$	693,408		$	672,991		$	20,417			3	%
Allowance for loan losses, beginning of period	$	9,092		$	9,192		$	(100	)		-1	%
Commercial		(4	)		(246	)		242			-98	%
Commercial Real Estate		-			-			-			0	%
Residential Real Estate		-			(3	)		3			-100	%
Consumer		(177	)		(187	)		10			-5	%
Total charge-offs		(181	)		(436	)		255			-58	%
Commercial		77			46			31			67	%
Commercial Real Estate		-			-			-			0	%
Residential Real Estate		-			11			(11	)		-100	%
Consumer		61			7			54			NM
Total recoveries		138			64			74			116	%
Net (charge-offs)		(43	)		(372	)		329			-88	%
Provision charged to income		-			272			(272	)		-100	%
Allowance for loan losses, end of period	$	9,049		$	9,092		$	(43	)		0	%
Ratio of net loans charged-off to average
gross loans outstanding, annualized		0.01	%		0.06	%		-0.05	%
Ratio of allowance for loan losses to
gross loans outstanding		1.29	%		1.32	%		-0.03	%

ABOUT PACIFIC FINANCIAL CORPORATION

Pacific Financial Corporation of Aberdeen, Washington, is the bank holding company for Bank of the Pacific, a state chartered and federally insured commercial bank. Bank of the Pacific offers banking products and services to small-to-medium sized businesses and professionals in western Washington and Oregon. At December 31, 2018, the Company had total assets of $907.9 million and operated fifteen branches in the communities of Grays Harbor, Pacific, Whatcom, Skagit, Clark and Wahkiakum counties in the State of Washington, and three branches in Clatsop County, Oregon. The Company also operated loan production offices in the communities of Tacoma and Burlington in Washington and Salem, Oregon. Visit the Company’s website at www.bankofthepacific.com.
Member FDIC.

Cautions Concerning Forward-Looking Statements

This press release contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other laws, including all statements in this release that are not historical facts or that relate to future plans or events or projected results of Pacific Financial Corporation and its wholly-owned subsidiary, Bank of the Pacific. These forward-looking statements are subject to risks and uncertainties that could cause actual events or results to differ materially from those projected, anticipated or implied. These risks and uncertainties include various risks associated with growing the Bank and expanding the services it provides, successfully completing and integrating the acquisition of new branches and development of new business lines and markets, competition in the marketplace, general economic conditions, changes in interest rates, extensive and evolving regulation of the banking industry, and many other risks. We undertake no obligation to update or revise any forward-looking statement. Readers of this release are cautioned not to put undue reliance on forward-looking statements.

Contacts:
Denise Portmann, President & CEO
Douglas Biddle, EVP & CFO
360.533.8873

The IR Group Inc.
IR CONTACT: 206-388-5785